Wise Borrower's Guide
Tips for Borrowing Wisely
Borrowing money is the opposite of saving. Borrowing is not a neutral act. Rather, borrowing money has significant consequences and carries risk.
1. Wise Borrowers Save Money.
Because they know borrowing money carries risk, Wise Borrowers save money when they can and rarely carry enough debt to cause them stress. Because they know life holds so many financial dangers, Wise Borrowers keep a stash of money set aside for emergencies. They are careful not to get caught without the ability to take care of themselves and their family.
2. Wise Borrowers Protect Their Cash Flow.
Cash flow is to your financial life as blood flow is to your body. Without the flow of cash, your financial situation can take a bad turn. Be disciplined enough to keep cash flowing thoughout the month. What does this mean in practical terms? It means that you pay attention to income and expenses to ensure you continuously have more income than expenses so that you have cash available before an expense arises.
3. Wise Borrowers Pay Cash When They Can.
It feels good to actually own an item you buy. For example, if you can save $100 a month for five months to buy a new chair, do it. You'll sit better knowing it's actually yours. And you'll walk out of the store standing taller because you'll know you saved money (no interest payments) and didn't grovel with the sales manager. And never buy for consumables on credit. If you don't pay off your credit card each month and keep a running balance, the happy meal you get in the drive through will cost you big bucks before it's paid off. It just doesn't make sense. Wise Borrowers pay cash.
4. Wise Borrowers Know Where They Stand.
On December 1, 2004, thanks to the Fair and Accurate Credit Transactions Act of 2003 [aka FACTA]), the major credit reporting agencies were required to provide consumers a free credit report once each 12 months. If you will take advantage of this provision of the Federal FACT Act, you'll be able to stay on top of the information maintained by the credit reporting agencies. You can receive all three reports at the same time once a year or space them out so that every 4 months you get a free credit report.
Here's a link to AnnualCreditReport.com, the site created by the major credit reporting agencies to make it easy for consumers to access their free credit reports. The site is at www.annualcreditreport.com
TIP: Space your requests for a free credit report by 4 months. For example, in January request your report from Equifax, then in May request one from Experion, and finally in September, request your credit report from TransUnion. In this way you may check your credit report three times a year allowing you to monitor it more frequently at no cost.
Your Credit Report contains detailed information about your personal history of borrowing and repaying what you have borrowed. Think of it as your "debt management history". Lenders use your Credit Report to inform their decision about your loan application and what it contains often influences the interest rate you pay on loans and credit card accounts.
It's important for you to know what information your Credit Report contains about you. Often, Credit Reports contain errors which can hurt a person's ability to borrow money at the best rate possible.
While many people know about the three major credit reporting agencies, there are actually four. The "big three" include Experian, Equifax and Trans Union. The fourth that many haven't heard of is Innovis.
A thorough explanation of the features of the Fair and Accurate Credit Transactions Act is available on the National Consumer Law Center's NCLC Analysis of FACTA.
Contact information for each of these credit reporting agencies is provided by LendersAndLoans on the Credit Reporting Agencies page.
5. Wise Borrowers Avoid Risky Loans.
"Risky Loans" include any loan you don't understand, any loan that makes it too easy to borrow more than you can afford to pay back, any loan that has the acronym "IO", many loans that contain the acronym "ARM", any loan secured under loose underwriting standards, any loan obtained by providing false information, any loan obtained by a borrower who didn't shop around ... you get the idea. Foolish Borrowers often think the extra letters "IO/ARM" on their loan makes it sound sexy or exotic. It's not.
Wise Borrowers are very careful about their borrowing behavior and make sure they eliminate as much potential risk as possible from the borrowing process. Some people call certain types of loans "boring" ... a 30 year, fixed rate mortage for example. A Wise Borrower chooses boring over exotic every time because she knows what the risks are and has them under control.
6. Wise Borrowers Do Not Buy Things They Cannot Afford.
This seems so obvious. However, so many people buy things they can't really afford to own. And then, because they can't afford their purchases, they find them impossible to enjoy!
Take a person buying boat for instance. Instead of purchasing a safe, used runabout for $3,500 they buy the latest in-board minicruiser for $35,000. It may be a little faster and a little more shiney, but it floats no better than the used runabout that costs 1/10 as much. Suppose the boat buyer will pay off the loan over a five year period. $3,500 for 5 years at 9.5% requires a monthly payment of $73.51. However, $35,000 for 5 years at 9.5% requires $735.07 a month! Suppose our boat buyer can only take the boat out one weekend per month ... would he rather be paying $73 per trip or $735? Again, this one seems obvious, but Wise Borrowers do not buy things they cannot afford.
7. Wise Borrowers Never Borrow Today Based Upon Fantasies About Future Income.
Your grandparents would have said it this way, "Don't count your chickens before they hatch." Borrowing that requires an increase in your future income is dangerous. Some say, "buy more house than you can afford today because you'll make more money in the future." While increased income in the future may be a possibility, it is not a guarantee. Your signature on a loan, however, is your guarantee. Don't sign for more than you can afford to pay with the income you have now. Why? Spouses become ill and cannot work, employers go out of business, gas prices rise offsetting future pay raises, etc. ... again, you get the idea.
8. Wise Borrowers Rarely/Never Co-Sign.
Co-signing is financially dangerous. If the person who asks you to co-sign refuses to pay, your signature as a co-signer makes you responsible for the debt, interest, penalties, etc. So, if you co-sign a loan for a famiy member or friend, you should plan on making payments. Wise Borrowers rarely/never co-sign.
9. Wise Borrowers Pay More Than the Minimum Monthly Payment.
Just do it. You'll pay off your debt sooner and free up your money for more productive endeavors. Wise Borrowers pay more than the minimum monthly payment.
10. Wise Borrowers Never Sign a Document They Do Not Understand.
Some people are embarrassed to admit they don't understand financial documents. Don't be. Unless you have a degree in finance or have an earned juris doctor, no one expects you to understand financial documents. (However, they will push the paper across the desk and say, "Sign by the X", as if they think you do.)
Ask questions until you understand everything. And if the amount you are borrowing is enough to hurt you, ask someone other than the loan officer or broker. Take the document with you to an attorney or financial planner whom you trust. Don't sign a document "because it looks good" when you scan it. Read ALL the fine print ... literally! The paperwork a borrower signs is usually prepared by the lender to protect the lender's interests (and they should be protected). However, you have valid interests as well which should be protected in the agreement you sign to borrow money. Make sure your side is covered.
11 (Bonus). Wise Borrowers Shop Around When They Borrow Money.
The chances are good you visited more than one car dealer before you chose the car you drive. And who buys the very first home they look at? Hopefully, no one you know. If you shop around for the items you wish to buy, doesn't it make just as much sense (or more, considering all the potential consequences) to shop around for the money you wish to borrow? If you need to borrow money, shop around by getting information from several lenders.